- How to include COVID’s impact on your business valuation.
- How the global supply chain crisis can impact a company’s gross profit.
- How the pandemic took intrinsic industry demand and pushed it forward (and what that means).
- Why company culture and goodwill may be even more of a competitive advantage in the time of COVID.
Since the COVID-19 virus reared its ugly head in the first quarter of 2020, every facet of our daily lives has been impacted. Nothing was left untouched, from where we work to how our kids attend school. Some businesses collapsed under the weight of restrictions, while others managed to hold on through the worst of the pandemic. While the impacts varied from company to company and sector to sector, one thing is for sure – no business was the same.
One often-overlooked way in which COVID-19 impacted businesses is their valuation.
There are still many businesses for sale and many people searching for a great company. While the due diligence process digs deep into a company's financial and cultural corners to determine whether it’s a good deal or not, one thing that is easy to forget is COVID-19’s impact. How did the business fare during the pandemic? More importantly, how will it perform in the future due to what happened during the pandemic?
While these questions might seem unknowable initially, there are many ways we can look at COVID’s impact on a company’s valuation – whether it affected things that might increase the purchase price or decrease the purchase price. By gathering this information, we can learn what sellers and buyers want and try to find the middle ground to reach a deal.
In this article, we will focus on the sectors we like to buy into, namely home services businesses. But this article will be helpful no matter what industry you’re looking in. Importantly, while certain effects of COVID can decrease the value of a business, they can also present an opportunity.
What Can Decrease The Price Of A Business?
Decrease In Hours Worked
While many home services could keep their doors open and the lights on during the pandemic thanks to their status as an essential service, the vast majority of businesses still felt the pinch.
As the virus spread through work crews and office staff, it meant that more people were taking sick days than usual. And often, there was no one else available to cover their shift. This meant the company wasn’t earning as much as it could during certain periods, leading to earnings volatility.
That volatility creates uncertainty and can indicate increased risk, which decreases the valuation multiple. A significant fluctuation in the company’s earnings over a period of time is often a red flag. Buyers should look into revenue trends to ensure the problem isn’t systemic. A decrease in hours worked during the pandemic may also indicate a staffing issue within the company.
When looking at revenue trends, you may want to compare the period of March 1st, 2021, to Feb 28th, 2022, to the same period the year before (March 1st, 2019, to Feb 28th, 2020).
Decreased Future Demand
As the pandemic caused more people to lock down in their homes, many of those people decided to invest in the homes they had been confined to.
Pools are a luxury that many homeowners will take years to save for. They will budget their money accordingly with the plan to buy one in three years, for example. But as those people were given few other entertainment options, many decided to buy sooner.
While this was an initial boon for some businesses, what actually happened in many cases was that the pandemic took the intrinsic demand in the industry from future years and pushed it up to the present.
“You can look at this from a P&L (profit and loss) perspective,” explains Acquira CEO Hayden Miyamoto. “If I saw that over the last five years, the business was growing five percent year over year, but during COVID grew 20 percent, I would assume that 20 percent growth will affect my future years’ growth.”
So, you should not buy a business based on a multiple of the year where business increased during COVID. You should also understand that the business will have less demand than it did in the previous several years because an external factor made your customer base accelerate their decision.
To counteract this effect, you must develop a way to attract new customers. This could mean expanding your product offering or a new marketing campaign – both of which have upfront costs you would have to consider.
Supply Chain Issues
It’s well-documented how the COVID pandemic caused supply chain issues across the globe. As CNBC pointed out, “the pandemic has highlighted deep fragilities in these networks, with disruption in one part of the chain having a ripple-down effect on all parts of the chain, from manufacturers to suppliers and distributors with disruptions ultimately affecting consumers and economic growth.”
The domino effect of those issues was even felt in industries like home services, where everyone from HVAC technicians to plumbers saw the cost of equipment and materials rise. Now, increases in the cost of goods is nothing new, but they usually happen annually or semi-annually. In 2021, they rose many times and by a high amount each time.
For example, from May 2020 to May 2021, prices for used cars and trucks rose 29.7 percent, according to the US Bureau of Labor Statistics. This can greatly impact companies that rely on trucks, like plumbers, roofers, and other home services businesses.
Ultimately, these increases lead to a decrease in gross profit. While supply chain issues can hurt a business, they may also present an opportunity, according to Hayden.
“Actually, I would still pay the same multiple for a company like that,” Hayden says. “I actually see that as an opportunity simply because that shouldn't be the case in the future.”
“If you're operating a business well, you would have a process to pass on these costs to customers immediately by updating your price books,” Hayden explains. “You would need to talk to your customers constantly and prepare them for it. It's just negligence on the owner's part to not update the prices.”
What Can Increase The Price Of A Business?
During periods of uncertainty like the COVID-19 pandemic, company culture can become even more of a competitive advantage. According to a 2019 study from Glassdoor, 77 percent of people would consider a company’s culture before applying for a job there. More than half say culture is more important than salary when it comes to job satisfaction.
While businesses of all sizes look to recover from the economic impacts of the pandemic, culture becomes even more important. Another pre-pandemic study showed that one in five Americans left a job due to poor company culture within a year of the survey. Remember that replacing an employee costs up to 150 percent of the employee’s annual salary and lessens productivity.
In the post-COVID world, company culture becomes intrinsically more important. For businesses with teams that stuck together through the worst of it and maintained morale (relatively speaking), culture is often the competitive advantage the business needs to succeed.
Brand Recognition / Goodwill
As the pandemic wore on, many consumers began to pay close attention to how businesses treated their employees. The businesses that treated their workers well were often rewarded through increased sales.
Many companies also saw a reprieve from the economic hardships as more people sought to “shop local” and support small businesses in their communities. These feelings of goodwill can be powerful motivators for consumers and can be a valuable asset in a post-COVID acquisition.
Can PPP Loans Help Or Hurt A Company’s Valuation?
The US government created the Coronavirus Aid, Relief, and Economic Security (CARES) Act to help businesses weather the pandemic. The government made several loans available to companies of all sizes, including the Paycheck Protection Program (PPP), Economic Injury Disaster Loans (EIDL), and the Employee Retention Tax Credit (ERTC).
When appraising a company’s valuation post-COVID, potential buyers must determine if the business received one of the above loans and then find out why it received one or more of these loans. Loans of this nature can indicate that the company has been struggling. If they’re reflected on the company’s financial statements, it likely won’t be an accurate representation of the future of the business.
If any of the CARES Act loans are forgiven, it will appear as income on the company’s financial statements, artificially inflating its earnings for the year. When appraising a business that received a one-time gain like this, the buyer should “normalize” the earnings for the year – essentially, make sure that CARES Act-related revenue is not included in the business valuation.
An important point is whether this will impact payroll calculations because a portion of the PPP loan will undoubtedly go to cover payroll costs. Expenses that the loan covers should be included as part of the valuation since those are normal operating expenses that any loan might cover, whether it is forgiven or not. The loan forgiveness is a one-time event, whereas payroll is an ongoing business expense.
Sellers Vs Buyers: What Do They Want?
In any buyout, the seller wants the valuation of their business to be as high as possible. This was true before and during COVID-19 and will continue to be true long after.
That means many sellers will point to the heightened profits they saw in 2021 to justify increasing the multiple they ask for their business. They may attempt to downplay the impact of illnesses on their workforce during the worst of the pandemic.
Buyers obviously want to decrease the price they will pay for a business as much as possible.
To rebut the seller’s arguments, the buyer must be aware of the issues. They need to know what caused profits to increase and why, and they need to be able to explain that to the seller during the negotiation process.
The bottom line is, whenever possible, try to discount COVID from the valuation of a business.
Still, you should always strive to understand the pandemic's impact on the business because every company is slightly different. So, you should be aware of the impacts and whether you think they should affect the value of the business.
If the COVID period proves to be a good year, many sellers will insist it remains in the valuation. If the same period was a bad year for the business, the seller will often insist on removing it from the valuation.
COVID-19 will have a long-lasting impact on all of our lives. It has overturned many of the norms we took for granted and caused economic turmoil worldwide, from where we work to how we value businesses.
As we said earlier, each business is different. Still, you should be aware of how COVID may have impacted the price – positively or negatively – and be able to explain your findings.
By looking into COVID’s impact on the business valuation, you should also begin to understand how all different aspects of the business interrelate. This will provide you with deeper insight into the business so that you can make an educated offer based on fundamentals.
Acquira’s training includes valuation calculators that will allow you to weigh the impact of COVID on any business you’re looking at. Those are included in our Accelerator Program, which is designed to help you find and acquire a business in half the time it would normally take. To learn how we can help you on your own acquisition journey, schedule a call today through the form below:
- Whenever possible, discount COVID-19 from your valuation.
- An increase in business during the pandemic likely means a decrease in future demand.
- A decrease in hours worked may signal earnings volatility and may decrease the valuation.
- Global supply chain issues can impact the gross profit of many businesses.
- Ensure that CARES Act-related revenue is not included in the business’ valuation.
- Company culture and goodwill can be a competitive advantage during economic downturns.
Acquira specializes in seamless business succession and acquisition. We guide entrepreneurs in acquiring businesses and investing in their growth and success. Our focus is on creating a lasting, positive impact for owners, employees, and the community through each transition.